Feature: Medibank Private IPO

Longer-term, it should do well on the stock market, without shooting the lights out, and reward the patient investor – remember that Medibank Private operates in a highly competitive market.

When the Australian Government floated the first tranche (portion) of CBA in September 1991, the shares cost $5.40 (subsequent tranches sold for $9.50 and $10.00). Investors who backed the initial CBA float and held the shares now have shares that trade for about $77, more than 14 times the purchase price. But the initial investors have also received a total of $42.48, for a total return of $119.48, or more than 22 times the purchase price.

The CBA dividends alone have paid off the original $5.40 purchase price more than seven times.

Another Australian government privatisation, CSL (the former Commonwealth Serum Laboratories) has rewarded shareholders even more handsomely.

CSL was floated at $2.30 in June 1994: a three-for-one share split in 2007 means that was effectively 77 cents. CSL now trades at $74.29 - meaning original shareholders have made 96.5 times their money, just on the share price. But original CSL shareholders have also received $8.275 in dividends: that makes a total return of 107 times your money!!

The original Telstra retail shareholders, who paid $3.30 in two instalments starting with $1.95 in November 1997, are showing a capital gain of 65% on the shares at $5.45, bit they’ve also received $4.385 in dividends. That makes their total gain just short of tripling their original investment.

Telstra 2 retail subscribers paid a total price of $7.40, paid in two instalments, October 1999 and October 2000. They’re still underwater on the share price, to the tune of 26%, but the $4.075 they’re received in dividends more than covers that loss, and puts them ahead by 29%.

Shareholders who entered the stock through the Telstra 3 issue, in November 2006, paid $3.60 in two instalments. At $5.45, they’re ahead by 51% on capital gain alone, but add $2.255 worth of dividends to this and they’re up by 114% in total.

OK, so we’ve established that government privatisations can do OK on the stock market.

Now let’s look at Medibank Private.

First of all, some progressive types might mourn the fact that the insurer is leaving “public” ownership for the more aggressive “private sector,” and will be run from now on for profit. I was asked by a TV news reporter whether this would be the case. I said, “I should hope so.”

Few people remember – and it is certainly not being shouted from the rooftops at the moment – that when the current chief executive officer, George Savvides, took over at Medibank, in 2002, it had lost $175 million and was on the edge of breaching its prudential capital requirement – meaning that the prudential regulator could have shut the business down or at least taken over. It would have been very embarrassing for the federal government for that to happen to its own health fund, so Savvides and his management team got the licence to do a complete rebuild.

Which they have, and then some. Medibank has paid dividends of about $450 million to the government over the past two years alone – including a 'special dividend' of $300 million paid in August 2013.

So, let’s look at the company and its float.

Medibank Private is the largest health insurer in Australia, offering insurance under the Medibank and AHM brands. Out of about 40 private health funds, national market share is about 30%, with its nearest competitor being BUPA Australia with about 27% of the market.

Medibank Private is not a not-for-profit company: it was fully corporatised – meaning it operates like a commercial business – by the Rudd government In October 2009. For this reason, Medibank Private’s premiums rise with the market.

Medibank Private expects to lift its revenue by 4.2% to $6.64 billion for the 2014/15 financial year. From that, it expects to earn operating profit of $282.1 million – up 10.5% from $255.3 million in 2013/14. But net profit is projected to be static, at $258.2 million.

The insurer plans to pay out between 70 and 80 per cent of its earnings as dividends in the future. For the seven months to June 30, 2015, Medibank Private expects to pay a fully-franked dividend of 4.9 cents a share.

At the indicative price range of $1.55–$2 a share, that equates to a dividend yield of between 4.2%–5.2%, and puts the potential share price at between 16.5 times–21.5 times expected earnings.

At the indicative price range, Medibank Private will come to the stock market worth somewhere between $4.3 billion–$5.5 billion.

All well and good, but how do we make sense of those numbers?

There is one direct comparison with Medibank Private that is already listed on the stockmarket – NIB Holdings (NHF), which is about the fourth-largest health insurer, with a 7.6% market share.

Workers at BHP Steelworks, Mayfield, established the Newcastle Industrial Benefits (NIB) Hospital Fund in 1952. Newcastle-based NIB was the first (and so far only) Australian health fund to demutualise and list on the ASX, which it did in November 2007.

NIB has been an outstanding performer on the stock market. Its five-year total return (capital gain plus dividends) figure is 28.3% a year. Over three years, it has returned 35.2% a year, while over the last 12 months it has delivered 43.5%.

About 280,000 of NIB’s 330,000 policyholders became shareholders. Institutions got the shares at 88.5 cents following a book-build: the shares opened at $1.14. The stock now trades at $3.02.

For the financial year 2013-14, NIB lifted earnings per share (EPS) by 4% to 15.9 cents, and its dividend by 10%, to 11 cents (plus a 9-cent special dividend). Revenue rose by 15% to $1.53 billion, while claims were up 12% to $1.2 billion.

NIB’s final return on assets (ROA) figure for the financial year was 12.4%, while return on equity came in at 27.8%.

The analysts’ consensus expectation for NIB’s earnings and dividend in the current financial year complied by (Thomson Reuters) place it on a forecast price-earnings (PE) ratio of 17.9 times earnings, and a fully franked dividend yield of 3.8%.

So Medibank Private is priced on a more attractive yield, and in the same ballpark in terms of PE, depending of course, on the final price.

That tells you that the government is prepared to be a little but more generous than it has to be on yield, while pitching the price in a neutral area, neither screamingly cheap nor overly expensive.

ROE is harder to figure out, because Medibank's most recent published accounts were for the year ended 30 June 2013, in which the return on equity was a touch over 15% – a long way short of what NIB can generate now.

Then there is the fact that as an insurer, Medibank Private generates almost 40% of pre-tax earnings from its investment portfolio: this can be a volatile source of profit – as recently as 2008-09, at the height of the GFC, its investment portfolio lost money for the year. This volatility complicates earnings projections.

There will certainly be demand from the stock market for the float. How much unsatisfied demand there will be depends on how much of the stock institutions get. Investors looking for a nice IPO premium on the day will need to see institutions scaled back in their demand for the stock – and hope that the US market does not fall 2%–3% on the night before Medibank Private’s debut.

Longer-term, it should do well on the stock market, without shooting the lights out, and reward the patient investor – remember that Medibank Private operates in a highly competitive market. Above all, don’t expect it to be another CSL – back then, the government had no idea what it owned, and what CSL could do with Brian McNamee at the helm.

James was founding editor of Shares magazine, and oversaw one of the most successful magazine launches in Australia. He has also written for BRW, Personal Investor, The Age and Management Today, and was subsequently personal investment editor at The Australian and editor of financial website, investorweb.com.au